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Financing models of energy efficiency project – an overview

As the market for energy efficiency evolves, new financing models involving third party lenders or investors are also emerging in order to address specific needs of the owners and service providers.

The market for energy efficiency products and services in India has gained momentum in the recent years. This is due to both regulatory impetus and commercial incentives for green building and industrial process efficiency.Energy saving products and services in India could offer interesting capital investment opportunities. It is estimated that such projects could save up to 49billion kWh for industries and another 4.5billion kWh in commercial and municipal buildings (refer B Natarajan’s presentation at the Asia Clean Energy Forum 2008).As per the Planning Commission data and based on national average tariff paid by these two consumer categories such figures, in monetary terms, potentially translate into US$4.6 billion and US$320 million respectively.

Energy efficiency projects often involve an energy saving performance contract (ESPC) between facility owner and a service provider, called the Energy Service Company (ESCo). The performance contract containslegal provisions between the two parties and lays out a code of best practices, liabilities, default conditions and remedies, indemnification provisions and insurance requirements. The ESCo carries out design and implementation of the project and this can take several forms including retrofits,process design and modification, installation of new equipment as well as control and management systems.Since performance contracts are negotiated based on future savings estimates, the role of proper monitoring and verification (M&V) of actual savings at pre-defined intervals during the contract periodremains a key issue.
Initially the funding sources of energy efficiency projects could be eitherthe owner or the ESCowho then earns returns based on saving on energy bills compared to abaseline. But as market evolves, new financing modelsare emerging in order to address specific needs of the owners and service providers. Six of such financing models are discussed briefly in the following sections.

Guaranteed saving model

The guaranteed saving model (see Figure 1) is termed so because the ESPC comprises performance guarantee by the project implementing ESCo. Third party lender finances the project and the facility owner provides it with recourse to their balance sheet. Therefore creditworthiness of the owner is a necessary condition. The owner in turn has recourse to the ESCo’s guarantee and is able to share some risks of the project. After repayment of loans and project payments to the ESCo, the owner earns the realized savings from their energy bill which effectively constitute the investment returns. It is also possible that the lender requires a guarantee from the ESCo for its payments.

Shared saving model

In the shared saving model (see Figure 2), it is the ESCo who invests in the project and assumes higher risk than the facility owner. This type of model is particularly helpful in case where the creditworthiness of the facility owner is an issue. One mitigation arrangement is to create a separate escrow account under the contract. The owner pays up all accrued saving into this account and all repayments of finance are channeled through it. Third party, who may lent to the ESCo, would normally have the first access to this account. Thereafter, ESCo receives its payment (an agreed percentage of the savings) and any excess is availed by the owner. However, unlike the first case, this last share of accrued savingsto the owner is not guaranteed.

Lease models – ESCo as the Lessor

When energy efficiency project involves installation of tools and equipment, lease finance as an option can be explored with the ESCo as the lessor (See Figure 3). As with any other lease, lesse i.e. the facility ownerpaysafixed rent for new installations for pre-agreed period and amounts. The ESCoavails secured loans for purchasing tools and equipment and the balance of lease rent and loan repayment are its returns. Surplus in the savings on energy bills of the facility ownersare retained by them.

Lease aggregation

Lease aggregation (see Figure 4) is possible if individual facilities do not amount to significant investment. In such cases, theESComay float a special purpose vehicle (SPV) which aggregates the leases and channels the repayments. Equipment manufacturers and third party investors may also acquire holdings in the SPV.

Development finance model

Development finance has played an important role in encouraging the markets for energy efficiency in India. This has particularly been noteworthy in supporting small, micro and medium enterprises with access to soft capital through a number of refinancing institutions (see Figure 5). A facility owner (or the enterprise) procures soft loan under favorable conditions and this helps covering their capital expenses. The performance contract between the owner and the ESCo can be structured on lines of the regular models such as guaranteed or shared saving as discussed earlier in this article.

Energy Service Agreement model – Investor/Lender at the center stage

This particular model has typically been used in relatively mature markets such as the US where a lender or investor takes the center stage in the energy efficiency project implementation and saving realization. In this model, the lender or investor executes an energy service agreement (ESA) with the facility owner to fund their entire cost of energy saving installation, upgradation and maintenance. In return, the investor or lender assumes responsibility of the utility bill paymentsand thereby captures all savings that accrue from the baseline, effectively charging the owner for avoided energy costs.There is a minimum pre-implementation energy billcriterion (typically US$ 1 million per annum or above) that facility owners needto satisfy under this model. Also, projects attract much higher capital than experienced in the previous models.
On the other hand, the lender or investor carries out a performance contract with the ESCo to provide capital for installation and maintenance services (or, even active energy management) at the owner’s facility on an ongoing basis. Such a contract may also have a provision for the ESCo to share profits from accrued savings.

Clearly, as the market develops, variants under each of the discussed financing models willsee evolution in maturity and complexity. . Also, new and innovative financial instruments are likely to appear for support and risk allocation amongst involved parties. Therefore, it is not only the industries, building sector and ESCos but also the financial institutionsthatare looking at energy efficiency with great interest.

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